Today we are going to look at Lypsa Gems & Jewellery Limited (NSE:LYPSAGEMS) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Lypsa Gems & Jewellery:
0.14 = ₹281m ÷ (₹3.7b – ₹2.3b) (Based on the trailing twelve months to December 2018.)
So, Lypsa Gems & Jewellery has an ROCE of 14%.
Is Lypsa Gems & Jewellery’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Lypsa Gems & Jewellery’s ROCE is meaningfully better than the 11% average in the Luxury industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from how Lypsa Gems & Jewellery stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Lypsa Gems & Jewellery’s current ROCE of 14% is lower than its ROCE in the past, which was 49%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Lypsa Gems & Jewellery has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Lypsa Gems & Jewellery’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Lypsa Gems & Jewellery has total liabilities of ₹2.3b and total assets of ₹3.7b. As a result, its current liabilities are equal to approximately 62% of its total assets. Lypsa Gems & Jewellery has a fairly high level of current liabilities, meaningfully impacting its ROCE.
The Bottom Line On Lypsa Gems & Jewellery’s ROCE
Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.